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Robo-advisers like Betterment LLC, Financial Engines Inc. and Wealthfront Inc. stand
to win a lot of business even if the Department of Labor fiduciary rule they avidly
support is revised or scrapped.

But as the number of retirement savers using robo-advisers increases, it’s also creating
the potential for those savers to lose a mechanism they might lean on to enforce their
rights: class actions. That’s because many robo-advisers require their customers to
arbitrate disputes and give up their right to class actions—one of the very things
the fiduciary rule is attempting to curtail.

A major component of the rule is that it allows advisers to work on commissions but
requires them to sign contracts with their customers and those contracts can’t make
arbitration mandatory. This provision could be one that the Trump administration targets,
particularly in light of
recent moves in Congress to stymie class actions.

The rule was scheduled to be implemented April 10, but the DOL has proposed a delay
as it complies with an order from President Donald Trump that it review the regulation.

Standard Practice

Robo-advisers provide investment advice through online, algorithm-based platforms
with varying degrees of human involvement. The industry is on track to have $2.2 trillion
in assets under management by 2020, up from $200 billion in 2016, London-based management
consulting firm A.T. Kearney said in a recent
report.

Bloomberg BNA looked at the client agreements or terms and conditions for 11 robo-advisers
and determined that the majority include arbitration clauses, either under the rules
of the Financial Industry Regulatory Authority, the American Arbitration Association
or the Judicial Arbitration and Mediation Services Inc. (JAMS).

Seth Rosenbloom, associate general counsel at New York-based
Betterment, told Bloomberg BNA in an email that such stipulations aren’t unique to his firm.
“Plan sponsors sign arbitration agreements and this is standard (with potential advantages
for both parties), as are the agreements themselves.”

Bloomberg BNA was unable to track down a Financial Engines client agreement, but the
company disclosed in its most recent regulatory
annual report filing that it uses pre-dispute clauses. It said, however, that changes in the legal
landscape could “invalidate pre-dispute arbitration clauses in our agreements, leading
to increased costs to litigate any claims against us.”

Arbitration clauses are the norm for the industry, Mike Jurs, director of public relations
for Financial Engines, told Bloomberg BNA in an email. “We don’t see any disconnect
between this standard practice and any technical requirements that other service providers
with different business models may have to comply with to manage their conflicts,”
he said.

And then there are the exceptions: Two of the agreements Bloomberg BNA reviewed don’t
mention arbitration. Rebalance IRA’s one-page
sample agreement includes a strict limits-on-liability clause and also states that clients don’t waive
their rights to claims under federal or state securities laws. New York-based LearnVest
Inc.
states that disputes will be handled in New York under state law.

Arbitration: Pros and Cons

Whether arbitration should be mandatory is a “very complex” question, Ron Rhoades,
director of Western Kentucky University’s financial planning program, told Bloomberg
BNA. “Many feel that claimants deserve their day in court, while others say a firm’s
reputation is its number one asset,” he said. Firms don’t want to see their reputations
destroyed in court by frivolous claims, he said.

In addition, it doesn’t appear that in practice, robo-adviser arbitration requirements
have been causing investors trouble. There is scant evidence that robo-advisers have
been involved in arbitration claims or enforcement actions. Bloomberg BNA found no
mention of the robo-advisers that specify FINRA as the preferred arbitration forum
on FINRA’s arbitration awards database. Advisory firms must disclose on their Form
ADV whether they have been subject to any disciplinary actions. All of the Form ADVs
that Bloomberg BNA reviewed showed that the companies had no material disciplinary
events.

On the other side of the ledger, arbitration can be prohibitively expensive for investors,
Andrew Stoltmann, president-elect and executive vice president of the Public Investors
Arbitration Bar Association, in Chicago, told Bloomberg BNA.

“I’ve long taken the position that a fiduciary who includes binding arbitration in
his new account agreement is stepping very close to the line in terms of breaching
fiduciary duty,” Stoltmann said. JAMS arbitration, for example, can cost at least
$25,000 before even getting an arbitration result, which “effectively closes the door
for anybody who wants to file a claim,” he said.

As expensive as JAMS is, the AAA could be even worse. “AAA is crazy expensive,” Nicholas
J. Guiliano, a securities arbitration attorney and founder of the Guiliano Law Firm
PC in Philadelphia, told Bloomberg BNA. An investor “could easily spend $50,000 for
an arbitration case, which will scare off claims, because nobody has the money to
bring” one, he said.

Could the fiduciary rule change the landscape? Maybe, maybe not. “Assuming the rule
stays in place—and that’s a massive assumption of course—I think that would arguably
trump any separate agreement” that a registered investment adviser “might have with
its customers,” Stoltmann said.

Arbitration agreements also prevent arbitrators from learning from one another to
the detriment of investors, Julie G. Reiser, a partner at Cohen Milstein Sellers &
Toll PLLC, in Washington, told Bloomberg BNA.

“The arbitration process is between private parties and typically arbitration outcomes
remain confidential,” Reiser said in an email. “This means that consumers who have
the same dispute against a corporation can receive different outcomes in arbitration
as there are no published opinions that create precedent for the next dispute. It
also means that companies can continue acting as if deceptive practices or defective
products are isolated and avoid public pressure to change. Transparency is a hallmark
of the court system that results in more corporate accountability.”

Although arbitration is perfectly legal, “there’s just no good reason to force one
avenue of dispute resolution before a dispute ever arises,” Reiser said.

To contact the reporter on this story: Sean Forbes in Washington at
sforbes@bna.com

To contact the editor responsible for this story: Jo-el J. Meyer at
jmeyer@bna.com

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